Top 5 Legal Due Diligence Findings In Dutch M&A Transactions | #2 Red Flags In Articles Of Association Of A Target Company

About This Series: Top 5 Legal Due Diligence Findings in Dutch M&A Transactions

In the dynamic landscape of mergers and acquisitions (M&A) in the Netherlands, the legal due diligence investigation remains one of the most critical phases of any transaction. During this stage, information from the seller is thoroughly validated, potential risks are identified, and the deal value is ascertained or sometimes fundamentally reassessed. A comprehensive due diligence process not only safeguards the purchaser by identifying risks and shaping negotiation strategies, but also benefits the seller and the target company by clarifying obligations, identifying operational improvements and aligning expectations.

This article marks the second in a five-part series on the Top 5 Legal Due Diligence Findings in Dutch M&A Transactions. For this series, we performed an in-depth analysis of the due diligence reports of our recent Dutch M&A transactions and identified the Top 5 Legal Due Diligence Findings. Each article in the series explores one of these findings as well as related topics in detail.

Summary of the article: Red Flags in Articles of Association in Dutch M&A Transactions

The articles of association (statuten) form the constitutional backbone of every Dutch legal entity. They typicallyset out the governance structure, internal decision-making procedures, shareholder rights and share transfer mechanisms (as applicable). The provisions of book 2 of the Dutch Civil Code (Burgerlijk Wetboek) (DCC) may, to the extent allowed under Dutch law, be deviated from; this allows for tailored arrangements per legal entity. As the articles of association ultimately determine the practical framework within which the target company and its corporate bodies may operate, they form a crucial component of any legal due diligence investigation. 

In this second article, we discuss a number of recurring findings encountered when reviewing the articles of association of Dutch limited liability companies. For each identified finding, we provide background information and explain how it may affect a Dutch M&A transaction. As a general takeaway: provisions in the articles of association that are not timely identified or properly assessed during legal due diligence may disrupt transaction planning, give rise to unexpected transfer obligations, or even affect deal certainty.

The key findings discussed in this article are:

1. outdated articles of association;
2. quality requirements (kwaliteitseisen);
3. blocking arrangements (blokkeringsregeling);
4. mandatory offer provisions (aanbiedingsverplichtingen);
5. restrictions on pledging shares; and
6. shareholders' agreements (SHA).

Outdated articles of association

On 1 October 2012, the Flexibilisation of BV Act (Wet vereenvoudiging en flexibilisering van het BV-recht) came into force. This legislation introduced a number of legislative changes for private companies with limited liability (besloten vennootschappen met beperkte aansprakelijkheid) (each a BV) in the Netherlands. Its principal aim was to increase flexibility in corporate structuring and governance, reduce formalities and enhance the freedom of shareholders in structuring the regulations governing BVs. Moreover, on 1 July 2021, the Management and Supervision Act (Wet bestuur en toezicht) entered into force. Among other things, this legislation substantially revised the conflict of interest rules (tegenstrijdig belang-regeling) for directors and supervisory board members, clarifying when a conflict of interest exists and introducing stricter procedural requirements for dealing with such conflicts.

During due diligence, we frequently encounter outdated articles of association. Although there is no statutory obligation to amend articles of association predating 1 October 2012, it is generally recommended to do so in order to ensure full alignment with current regulations. Companies may otherwise be unable to (fully) benefit from the simplifications and the possibility to include tailor-made arrangements in the articles of association. 

In the context of an M&A transaction, outdated articles of association may limit a purchaser’s post-closing plans. Purchasers should therefore assess whether any amendments are desirable or required as part of the overall transaction and for the purposes of future corporate governance of the BV and the group as a whole. In that context, we note that a simple name change, which frequently occurs following an acquisition, already requires a formal amendment.

By way of illustration, we note that the following changes were introduced since 2012: 

• a notice convening a general meeting may be given electronically (unless the articles of association provide otherwise) (article 2:223 paragraph 2 DCC); 
• the statutory notice period for convening a general meeting has been reduced to eight (8) days (article 2:225 DCC); 
• written resolutions adopted outside a general meeting no longer require an explicit statutory basis in the articles of association (article 2:238 DCC); 
• a general meeting can be held at a specific location outside the Netherlands (article 2:226 paragraph 1 DCC); and 
• the concept of authorized share capital (maatschappelijk kapitaal) (which determines the maximum amount of share capital a BV can issue) has been abolished under the Flexibilisation of BV Act (article 2:178 DCC). 

If articles of association contain outdated provisions (such as references to authorized share capital or an unnecessarily extensive balance sheet test (balanstest) for distributions), such provisions remain in force and may impose unnecessary limitations. Moreover, pre-2012 articles of association will also typically not reflect the statutory distribution test (uitkeringstest) introduced under the Flexibilisation of BV Act, which requires management board approval for distributions.

Also, as stated above, Dutch law offers considerable scope for tailor-made arrangements in the articles of association. For example:

• a BV may issue different classes of shares to allocate varying rights to shareholders (article 2:228 DCC). The law expressly allows for the issuance of non-voting shares and non-profit shares. In addition, the articles of association may grant shareholders of a specific class of shares the right to appoint, suspend and dismiss certain directors, thereby enabling a differentiated governance structure aligned with the interests of a particular shareholder;
• shareholders are free to determine that no transfer restriction applies to the transfer of shares or include tailor-made transfer restrictions, provided that any restriction does not render the transfer of shares impossible or excessively onerous (article 2:195 DCC); 
• the articles of association may stipulate, in respect of all or certain classes of shares, that shareholdership is subject to specific quality requirements (kwaliteitseisen) (article 2:192 DCC); and
• the articles of association can determine that shareholders are obliged, under certain circumstances, to transfer their shares (article 2:192 DCC), and non-compliance with such transfer obligations may be sanctioned through measures such as the suspension of voting rights or profit rights.

Quality requirements (kwaliteitseisen)

A recurring due diligence finding concerns the inclusion of quality requirements in the articles of association (article 2:192 DCC). Quality requirements restrict the holding of shares in the capital of a company to specific persons meeting the specifications listed in the relevant provisions. These specifications are not subject to specific statutory requirements and may be freely tailored to the preferences of the shareholders. The quality requirements can, for example, state that only holders of a specific permit or members of a certain association may become shareholders or that a person cannot become shareholder if a person sharing the same ultimate parent company already holds shares in the company.

The impact of quality requirements in the articles of association in an M&A context can be significant. If a purchaser does not meet the stipulated criteria, a share transfer may not be permissible without first amending the articles of association– potentially delaying closing and necessitating additional conditions precedent to protect the purchaser and make the transaction legally possible. Some articles of association allow shares to be transferred even if a purchaser does not meet the quality requirements, if the management board or the general meeting of the company grants a dispensation (ontheffing) from the applicable quality requirements. Such dispensation provisions typically require the management board to assess whether the transfer would be in the company's interest and may be subject to conditions or time limitations.

Finally, a purchaser in an M&A transaction should determine not only whether it satisfies the quality requirements, but also whether prior share transfers met these requirements. A share transfer in violation of quality requirements creates a defect in the seller's legal title to the shares, meaning that the seller may not have validly become a shareholder. As a result, any historical corporate resolutions may be called into question. Depending on the circumstances, remedying such situations may include the ratification of defective share transfers (where legally possible) and the adoption of corrective corporate resolutions. In addition, transaction documentation should specifically address any residual risk, for example through specific warranties, indemnities and conditions precedent.

Blocking arrangements

The articles of association of BVs may include share transfer restrictions, generally referred to as blocking arrangements (blokkeringsregeling) (article 2:195 DCC). These arrangements restrict or condition the transferability of shares in order to prevent existing shareholders from being confronted with an unwanted third-party shareholder. As a result, shares in a BV are not necessarily freely transferable.

Blocking arrangements typically take the form of either a right of first refusal (aanbiedingsregeling) or an approval requirement (goedkeuringsregeling). Under the right of first refusal, a shareholder intending to transfer shares must first offer those shares to the other shareholders, usually on the same terms and conditions agreed with the intended third-party purchaser. Under an approval requirement, the transfer of shares is subject to the prior consent of a designated corporate body, such as the general meeting or the management board. The articles of association may also provide that shares are freely transferable and are not subject to any blocking arrangement. Where the articles of association are silent on the transferability of shares, the statutory default rule of article 2:195 DCC applies, pursuant to which a right of first refusal in favor of the other existing shareholders is in place.

From a due diligence perspective, it is important to assess not only the existence and scope of any blocking arrangements, but also whether they have been complied with in the past. Similar to non-compliance with quality requirements, described above, a share transfer effected in violation of applicable blocking arrangements results in a defect in the seller’s title to the shares.

In an M&A transaction, it is therefore essential to identify blocking arrangements at an early stage and determine how they can be addressed within the transaction timeline. This may involve obtaining waivers or consents from the relevant shareholders or corporate bodies or ensuring that the procedural steps prescribed by the blocking arrangements are properly followed prior to closing. If not timely and properly identified and managed, blocking arrangements can delay signing and/or closing or, in more adverse scenarios, undermine deal certainty where shareholders use such mechanisms strategically in order to prevent or obstruct the deal.

Mandatory offer provisions

The articles of association of a BV may contain mandatory offer provisions (aanbiedingsverplichtingen) (article 2:192 DCC). These provisions require a shareholder, upon the occurrence of certain predefined events, to offer its shares for transfer to (one or more of) the other shareholders or to the company itself. Common trigger events include the bankruptcy (faillissement) or suspension of payments (surseance van betaling) of a shareholder, a change of control or a shareholder no longer meeting applicable quality requirements. Mandatory offer provisions typically specify to whom the shares must be offered, the applicable pricing mechanism and the timeframe within which the offer and subsequent transfer of shares must be completed. The articles of association frequently attach sanctions to non-compliance with a mandatory offer obligation. Such sanctions may include, among other things, the suspension of voting rights or dividend rights.

From an M&A perspective, mandatory offer provisions are a critical due diligence focus area. It is essential to assess whether the contemplated transaction, or events occurring in connection with it, may trigger a mandatory offer obligation and, if so, to obtain the necessary waivers in a timely manner.

Restrictions on pledging shares

Some articles of association restrict or even prohibit the pledge of shares (hetverpanden van aandelen). This may pose an immediate transaction risk if acquisition financing, other deal structures or post-closing plans require a pledge over the shares in the target company. 

If such restrictions exist, an amendment to the articles of association may be required, potentially prior to closing, in order to permit the contemplated pledge. Depending on the transaction timeline and the cooperation of existing shareholders, this can introduce delays, additional transaction costs and execution risk. Purchasers and their financing parties should therefore identify any pledge restrictions at an early stage of the due diligence process, factor the required steps into the transaction timeline and include the amendment of the articles of association as a closing condition where necessary.

Shareholders’ agreement

Where a company has more than one shareholder, the relationship between shareholders is in practice often further governed by a SHA. While the articles of association constitute the company’s formal constitutional framework, a SHA allows shareholders to agree on additional arrangements or to further elaborate on provisions set out in the articles of association. SHAs commonly contain provisions relating to, among other things, pre-emption rights, tag-along and drag-along rights, non-compete obligations, deadlock mechanisms and dividend policy arrangements.

Provisions included in a SHA may give rise to risks similar to those associated with the articles of association, such as approval requirements for share transfers or obligations triggered as a result of the contemplated transaction. Accordingly, SHAs should be reviewed alongside the articles of association to ensure all transaction-relevant restrictions, obligations and approval rights are identified and appropriately addressed. It is furthermore essential to assess the interaction between the articles of association and the applicable SHA. In practice, inconsistencies between these documents are not uncommon and the hierarchy between them may not be immediately apparent. A careful and structured analysis is therefore required to determine their respective scope and assess the potential impact on the contemplated transaction. Finally, parties to an M&A transaction should assess whether the SHA is to be amended or terminated following closing of the contemplated transaction.

Top 5 tips: assessing articles of association

1. Align articles with the deal structureand post-closing plans – consider whether the existing articles of association and, if applicable, the SHA, are compatible with the intended deal structure (for example, whether share pledges required for acquisition financing are permitted) and the purchaser’s intended post-closing plans for the target company and the group’s governance or whether an amendment of the articles of association and/or SHA is required. 
2. Identify transaction-triggered provisions – analyse whether the contemplated transaction, or events occurring in connection with it, may trigger mandatory transfer obligations or other consequences under the articles of association and, if applicable, the SHA.
3. Obtain required documentation – establish which waivers, approvals and corporate resolutions are required (and from which parties), engage with the relevant stakeholders and initiate the process of obtaining the necessary documentation at an early stage.
4. Review the SHA alongside the articles of association – check whether any SHA is in place and, if so, analyse its provisions alongside the articles of association to identify potential conflicts or transaction-triggered obligations.
5. Involve the civil-law notary early – liaise at an early stage with the involved civil-law notary to confirm the required documentation and corporate actions.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.